1. How much of the R&D team’s work focuses on new product development and/or process improvement, rather than business-as-usual maintenance?
In most R&D incentive regimes, the definition of eligibility includes development of new and improved products, processes and services, with the involvement of some level of scientific uncertainty.
Take a food processing company looking to increase throughput by 10% on its packaging line, for example. They may buy new equipment and try to integrate it by conducting plant trials of the new process while also experimenting with key ingredients. Vineyards, meanwhile, may conduct experiments related to soil management and plant varieties to improve grape yields. In both cases, many activities undertaken to resolve these technical challenges may qualify for relief.
Yet much of what qualifies as R&D may be missed. Those who do the work may see it as simply an unremarkable or routine part of their day-to-day, while sometimes it can be hard to unpick R&D-specific tasks, especially in broader manufacturing areas.
“The challenge often lies in applying the government’s definition of R&D to a particular sector,” says Frank Buffone, EY EMEIA and UK&I Quantitative Services and Innovation Incentive Leader. “Pure research taking place in an R&D center, at say a pharmaceutical company, is usually easier for companies to manage as most if not all activities in these R&D centers are highly qualifying by their very nature. However it becomes more difficult to carve out eligible R&D projects in manufacturing areas where the R&D activities are among a broader range of routine manufacturing activities.”
In order to successfully sustain R&D tax credits that are claimed, it is vitally important to have the appropriate documentation in place to support the eligibility of R&D projects. And it is helpful for companies to capture this project information contemporaneously throughout the year as activities are taking place as opposed to generating that documentation at a later time.
2. What patents did the R&D team register last year? What patents do they plan to register this year? And how integral are these patents to their products?
The fact that a company has patents, either pending or successful, provides a clear indicator that it’s engaged in innovative R&D activity. And that it may be eligible for R&D incentives. Whilst this provides a good indicator, in many R&D regimes a patent is not a requirement for the R&D project to be eligible for R&D tax credit relief.
Certain countries — including a number of EU Member States, the UK and, from July 2022, Australia — operate a patent box regime, which guarantees a tax reduction on income from their patents to companies that meet set criteria.
And this applies to any product that uses the patented component. A UK kitchen manufacturer, for example, recently designed and patented a new cabinet leg that was used across its full range of floor-standing units. All those products were therefore eligible for the patent box credit.
3. What advances are the R&D team making from a sustainability or carbon footprint perspective, in both the manufacture of products and development of processes?
The fact that a project is driven by sustainability goals should be another signal to the tax team that R&D activities are likely being undertaken — either because the company is required to do so by new regulations, or in response to changing market demands. And, therefore, that it’s worth investigating eligibility for R&D incentives.
As events like the UN’s COP26 push the issue of sustainability further into the spotlight, much of the focus is now on companies to reduce their carbon footprint. As such, new, sustainable processes, as well as products, are set to form a critical component of R&D — whether that’s finding new, clean and cost-effective ways to produce hydrogen, or developing groundbreaking carbon capture technologies.
“Securing valuable R&D incentives to enable action on climate change, as well as staying on top of the rapidly evolving sustainability tax landscape across the globe, is critical,” says Susan Bishop, EY Canada Quantitative Services and Business Incentives Leader. “There are a wide range of sustainability-related projects that can qualify for the R&D incentives, including adopting new carbon capture technologies or new research in areas such as improved battery life, use of recycled materials, etc.”
4. What areas of the company are investing in software development or migrating to digital?
Costs associated with software development or migrating systems to digital should also be considered. Craig M. Frabotta, EY Global Research Credit Leader, explains, “Many of the companies with whom we speak, regardless of their size or sector, are spending money on software development. Often, these activities take place within the traditional IT department, but it’s not uncommon for us to uncover similar activities in other parts of the organization where the tax department would never have known to look.”
It's not only software that is made available to third parties via sale, lease or license that is eligible. For example, many companies are investing in software that keeps them relevant by allowing for better and more timely interaction with their customers who can conduct a transaction via an app – perhaps buying an insurance policy, ordering food, renting a car, etc. Other companies may be developing software that goes into their more traditional products – technology for driverless cars.
As with R&D activities in a manufacturing plant setting, it’s not always easy to identify and carve out qualifying software development projects. Sometimes the associated expenses are buried in the budget of a larger platform or program.
5. What plans does the company have to expand its R&D capacity, or to conduct R&D work in other locations in future?
Communication between tax and R&D teams should keep one eye firmly on the future to help guide strategic decisions. The process of choosing a location is incredibly complex, but incentives are an increasingly important factor.
If a business is already looking to make an R&D investment, as part of the decision making process, it makes sense to see if that investment can be directed towards a jurisdiction offering compelling incentives — making it more attractive.
Some countries will seek to attract companies that foster particular skill sets, such as process engineering or IT engineering, for example. And they will offer specific incentives around R&D in this field.
“When companies are looking to determine where they’re going to put their R&D center and their technical people, it comes down to more than just funding,” says Buffone. “They’ll look at everything from the economy, labor, proximity to the market and more. But while they won’t put their R&D in, say, the US simply because it has a great incentives regime, incentives do play an increasingly important role in these decisions.”
The global picture can be difficult to navigate. On the one hand, jurisdictions offer their incentives with a range of terms and conditions that may negatively affect their relative value in practice. For some countries, for example, R&D activities must be undertaken locally in order to claim incentives. Others, however, allow them to take place overseas. On the other hand, by understanding the different types of incentives that are available (e.g, credits, grants, negotiated incentives, etc.), there may be an opportunity to “layer” incentives on top of each other to generate an even larger value proposition.
As such, the interplay of incentives and R&D location decisions needs to be well understood. “Incentives should become part of the standing agenda at the leadership table,” says Bishop. “This conversation is an area of improvement for a lot of companies. By astutely mapping future plans against incentive opportunities, they can generate more working capital for the business, and keep a competitive edge.”
Given the importance of location decisions, it can be wise to engage an experienced third party in these discussions. Automated tools, including the latest advances in data analytics and machine learning, can also be useful to foster the required cross-functional collaboration, and to help tax and R&D teams stay abreast of the complex picture — both in terms of the incentives being offered, and the relevant R&D activities within the company.
Conclusion
R&D incentives are an increasingly popular tool for countries seeking to attract innovative businesses to their shores to help boost innovation, GDP and job creation. These incentives can provide an important capital boost for companies, and are becoming an important factor when businesses are deciding where to locate R&D teams.
But to really get the most out of R&D incentives, companies need to understand the work they are doing now and work they will do in the future as well as how it pertains to the incentives being offered around the world. By improving the communication between their tax function and R&D and engineering teams, companies can expect their existing R&D incentive claims to become more robust, thus boosting their access to working capital, and to play an important role in future strategic decision-making too.
