South Africa’s research and development (“R&D”) incentive is contained in section 11D of the Income Tax Act, No 58 of 1962 (‘the Act’), and was introduced with effect from November 2006. Just as taxpayers were becoming familiar with section 11D, the section was overhauled in terms of the Taxation Laws Amendment Act, No. 24 of 2011 (“TLAA”).
The TLAA provides that the revised section 11D comes into effect on 1 April 2012 or such later date as determined in terms of a Government Gazette. To our knowledge no such “later date” has been published and the revised section 11D is therefore technically in force. However, the draft Tax Administration Amendment Bill, 2012 indicates that the effective date will be postponed to 1 October 2012 and that the reference to the publication of a “later date” will be deleted. The Department of Science and Technology (“DST”), the “custodian” of the incentive, has informally indicated that it regards the effective date of the amendments to be 1 October 2012.
We set out below a brief summary of the benefits and requirements of the revised section 11D.
In terms of the incentive, a taxpayer is firstly entitled to a 100% deduction of all qualifying expenditure, that is, expenditure actually incurred directly and solely in respect of R&D if that expenditure is incurred in the production of income and in the carrying on of any trade. Secondly, an enhanced deduction of 50% may be claimed by a company which carries on the R&D. For purposes of the incentive, the person who may determine or alter the methodology of the R&D is regarded as the person who is carrying on the R&D.
The enhanced deduction is subject to approval by a Committee and may only be claimed in respect of expenditure incurred after the date of lodging of a successful application. We understand that the Committee is in the process of being established. In terms of the legislation, it will comprise of three DST employees, one National Treasury employee and three employees of the South African Revenue Service (“SARS”).
Specific provisions apply where a taxpayer funds R&D carried on by another person. In such cases, the enhanced deduction may be claimed by taxpayers other than companies, subject to certain limitations.
Allowances are also available in respect of qualifying plant and machinery or improvements (on a 40/20/20/20 basis) and qualifying buildings (5% per annum). The capital allowances do not extend to improvements to buildings. It is not clear whether this was an oversight.
A welcome change to section 11D is the introduction of a definition of the term “R&D”. The definition largely captures the activities envisaged in terms of the “old” section 11D but also expands the scope of the incentive to certain pre-existing products and processes. In particular, R&D is defined as:
- systematic investigative or experimental activities of which the result is uncertain for purpose of discovering non-obvious scientific/technical knowledge, or creating an invention, a registerable design, a computer program (as defined in the relevant IP legislation) or knowledge essential to the use of such invention, design or computer programme; or
- developing or significantly improving any qualifying invention, design, computer program or knowledge if such development or improvement relates to any new or improved function or improvement of performance, reliability or quality.
Certain expenditure is specifically excluded from the scope of section 11D. This comprises expenditure in respect of:
- administration, financing, compliance or similar functions;
- market research, market testing or sales promotion;
- routine testing, analysis, collection of information or quality control in the normal course of business;
- development of internal business processes, unless such processes are mainly intended for sale or for granting the use or right of use thereof. As in the case of the “old” section 11D, the term “internal business process” is not defined. Since SARS has in the past applied a narrow interpretation in this regard, the exclusion in respect of processes which are developed for the purpose of sale or granting the right of use is a welcome amendment;
- oil and gas or mineral exploration or prospecting, except R&D carried on to develop technology used for that exploration or prospecting; and
- creating or development of financial instruments or financial products. Whilst the term “financial instruments” is defined in section 1, “financial products” is not and it is anticipated that there will be interpretational issues in this regard.
Expenditure in respect of the creation or enhancement of trademarks or goodwill is also specifically excluded from the scope of section 11D, together with expenditure envisaged in sections 11(gB) and 11(gC) of the Act.
In summary, although the revised section 11D appears to have certain benefits, such as an extended scope in respect of pre-existing products and processes and the certainty that comes from obtaining approval in respect of R&D projects, it is suggested that the practical implications of obtaining approval will dictate the success of the incentive going forward.