Singapore’s R&D tax regime is in need of disruption
As published in The Business Times on 3 January 2018
Written by Lee Tiong Heng and Eugene Penafort, Tax Partner and Tax Manager of Deloitte Singapore respectively. The views expressed are their own.
In August 2017, Singapore’s Finance Minister Mr Heng Swee Keat mentioned at an industry event that investments in Research and Development (R&D) by businesses in Singapore saw a growth of 8 percent (%) year-on-year from 2010 to 2015. In the same speech, he made a point that even though this increase in R&D investment is encouraging, companies should not simply innovate in silos. Instead, they should be open to new possibilities and look outside of themselves, bringing together knowledge and insights across different areas, in order to really champion innovation and affect change.
With this sentiment, it can be argued that the impending demise of Singapore’s Productivity and Innovation (PIC) scheme is counter-productive. Without it, what would happen to the momentum within Singapore’s R&D ecosystem that the scheme has painstakingly helped build up? Would it be such a disruption that it would cause the slowdown of desire and motivation to innovate?
Developments beyond Singapore’s shores
Singapore’s neighbours, particularly Malaysia, Thailand and the Philippines, have started ramping up R&D tax incentive offerings. Further north, Hong Kong, taking a leaf out of Singapore’s playbook, has introduced R&D initiatives similar to what is offered under Singapore’s PIC scheme. Underlining the importance of encouraging innovation and consequently R&D as a key driver of long-term economic performance, Hong Kong’s Chief Executive Carrie Lam, in her maiden policy speech no less, proposed a 300% tax deduction for the first HK$2 million in eligible R&D expenditure and a double-deduction (or 200%) for the remainder.
More broadly, the latest OECD 2017 Science, Technology and Industry Scoreboard reveals that R&D tax incentives remain a major tool for promoting business R&D expenditures in OECD and partner economies. In fact, the number of OECD countries that give preferential tax treatment to business R&D expenditures nearly doubled from 16 in 2000 to 30 in 2017. Additionally, across countries including Japan and Korea, R&D intensity in the business sector was found to have a positive correlation with the level of government support towards business R&D expenditures. While this government support includes both R&D tax incentives and direct support, it is worthwhile noting that, according to the OECD July 2017 Tax Incentive Indicators, a clear majority of countries showed an increase in the relative importance of tax incentives over the years.
What then, if not PIC?
It is clear that Singapore must not, and cannot, slow the pace of its R&D initiatives.
As the next step after the PIC scheme runs its course, the Singapore government can perhaps adopt a hybrid approach of both targeted and broad-based R&D tax incentives. For instance, sectoral-focused R&D tax incentives can help encourage R&D activities in specific strategic areas while broad-based R&D incentives can help support all other value-creating activities that may have fallen through the cracks.
In Asia, Japan and Korea are the leaders in terms of R&D intensity, with 3.3% and 4.2% gross domestic spending on R&D respectively, according to OECD figures. For Singapore to maintain its high position in the R&D space amidst this intensity, the government can consider increasing the super deductions for qualifying R&D expenditure from 50% to at least 200%. This would be in addition to the 100% base deduction given. Doing so will give Singapore a competitive edge over Hong Kong, and potentially attract more global business communities and organisations to move their R&D activities here.
As an alternative to granting additional tax deductions on qualifying R&D expenditure, the Singapore government may wish to grant R&D tax credits instead. The credits could be calculated based on the R&D expenditure incurred at a certain prescribed rate - 50% for example. A benefit of the R&D tax credit is that it would not disadvantage businesses that have income taxed at a concessionary rate from taking on R&D activities.
A multi-tiered R&D tax credit, similar to what Australia has, can also be introduced to provide greater support not just for companies undertaking R&D in key sectors targeted by the government, but also for smaller companies with lower revenue. The R&D tax credit can be utilised in conjunction with a refundable credit for companies in a tax-loss position to help with cash flow, and an incremental R&D tax credit can be used to encourage increased investments in R&D.
Expanding on our suggestions so far, Singapore could reassess the definition currently used to determine the breadth and depth of the activities that would qualify for R&D tax incentives. Innovation in its current form is wide-ranging and much broader than the current definition of R&D in the Income Tax Act. There is little direct support for companies undertaking what is defined as the “lower tier” of R&D, which could include innovating their business models to do things better and differently. While these activities may be more evolutionary than revolutionary, any knowledge or experience gained is surely invaluable and potentially a stepping stone toward the next “unicorn”. These activities should be supported via an expansion of the R&D definition, or through a separate category that provides a lower tax deduction or tax credit.
Currently, downstream incentives that support R&D include the new Intellectual Property Development Incentive (IDI). While specific details have yet to be released, the idea behind the IDI is to incentivise the commercialisation of Intellectual Property (IP) in an attempt to encourage and support innovation in Singapore. However, there should not be an expectation that every R&D effort will lead to a successful commercialisation.
The upstream incentives mentioned earlier support these efforts without commercialisation expectations with a view that R&D efforts, big or small, birth forth the value creation chain. After all, it would be meaningless to commercialise what is not created.
Singapore cannot afford to rest on its laurels. If it does, there is a danger of companies relocating their knowledge-creating activities to other seemingly more attractive jurisdictions, some of which have very clear cost-advantages. Singapore must continue to remain attractive not only to companies who are currently active in high-value creation, R&D and IP-related activities, but also to those that are seeking opportunities to embark on their R&D journey.
To this end, perhaps all it comes down to is for Singapore to improve or maintain its broad-based R&D tax measures instead of allowing them to taper down to a mere 50% additional deduction come 2018. Out of the suggestions we posited in this article, the key could very likely be a hybrid approach that capitalises on the strengths of both targeted and broad-based R&D tax incentives.
Having planted the seeds of innovation just a few years ago, the tree is just beginning to flourish. We must be careful not to prune the branches prematurely, for if we do, it may be more difficult to start again from the ground up.