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Fiscal Incentives to spur Innovation

 
 
Fiscal incentives to spur innovation

 

Roopen Roy

 

(Roopen Roy is the Managing Director of Deloitte Consulting, India. Views expressed are personal)

 

We hate comparisons with China. But it is sometimes good to wake up and smell the coffee. India lags behind China in spending on research and development. The number of people dedicated to core research in India is about 150,000 compared with between 800,000 and 1 million in China. Who said this? None other than our own  Kapil Sibal who heads the Ministry of Science and Technology.

In the Scandinavian countries, the number of people conducting research is 7000 per every million. In the USA, the corresponding number is 4700. If we wanted to catch up with the US benchmark, we would need about 5 million people engaged in research. Looked at another way, we spend 0.8% on R&D compared with 1.23% in China (their GDP size by the way is nearly 5 times ours) .Developed countries spend 3% of their GDP in R&D. Shri Sibal has, however, gone on record to say that “our R&D expenditure is higher compared to countries like Argentina, Cuba, Sri Lanka and Pakistan” but that is hardly an achievement to crow about.

 

There is consensus from the President of India to the man in the tea shop, that our government must increase its outlay on R&D. But there are limitations on what the government alone can do. Despite the huge outlay in R&D in defence, only 30% of US’s R&D expenditure is in the government sector. In Japan, it is only 18%. The bulk of investments in the developed world comes from the private sector. In our case 80% of our R&D spend comes from the public sector.

India’s  aspiration  of becoming a “super-power” will remain a pipe dream if we are not able to scale up our R&D and provide incentives to the private sector and increase their R&D spend  several times its present size. To do so, a number of steps must be taken in parallel. Being involved closely with some institutions of higher learning, I am painfully aware of the challenges: our R&D infrastructure, the lack of incentives to attract the highest calibre students to R&D and the quality of higher education imparted in some of our universities. I will also readily concede that providing incentives to the private sector is not the single magic bullet that will solve all our R&D issues.

 

Having said that, I think fiscal incentives present us with a tool that we must use well and wisely. In this article, I will focus on the use of fiscal incentives to spur R&D spend and examine the Canadian model. Why Canada?  Because Canada has successfully assisted businesses particularly in the small sector.  In India, we need a fiscal incentive program that targets small and medium sized enterprises (SME sector). SMEs will create the bulk of new jobs that we need for our youth.

Presenting the Union Budget 2010-11, the Finance Minister has proposed the following, “I now propose to enhance the weighted deduction on expenditure incurred on in-house R&D from 150 per cent to 200 per cent. I also propose to enhance the weighted deduction on payments made to National Laboratories, research associations, colleges, universities and other institutions, for scientific research from 125 per cent to 175 per cent.” It is indeed a step in the right direction. 

The private sector accounts for about 20% of R&D and 6 industries account for over 60% of the spend: pharmaceutical, automotive, electrical and electronics, chemicals and defence-related -the leader being the pharmaceutical industry which alone accounts for 20%.

Turning to Canada, the corporate income tax system there is a combination of federal (central) and provincial (state) income taxes.   The federal corporate income tax system in Canada provides a number of significant tax incentives for companies conducting R&D in Canada. Canada’s Scientific Research and Experimental Development (SR&ED) program is among the  world’s richest and arguably the largest program of government support for innovation.  Repeated studies by the Conference Board of Canada, have found that the after-tax cost of R&D expenditures in Canada are lower than in all other G-7 nations.  Each year, the SR&ED program provides over $4 billion in investment tax credits to over 18,000 companies. Of these, about 75% are small businesses. 

 

Work that qualifies for SR&ED tax credits includes: experimental development, applied and basic research.   Interestingly, Canada’s program is tilted towards smaller companies. For large companies, the rate of the credit is 20 per cent of R&D expenditures. The rate of SR&ED tax credit for companies eligible for the small business deduction - the Canadian Controlled Private Corporations (CCPCs) - is 35 per cent. A 100 percent refund for current R &D expenditures and a 40 percent refund for capital R & D expenditures are extended to CCPCs with some qualifications.

 

More than 30 countries have enacted some form of R&D incentives. Incentives come in the form of credits, deductions and cash refunds.  Interestingly, selective tax support for R&D performed by small firms is not very common. There are only four countries—Canada, Italy, Japan and Korea— that have programs which provide tax credits for small-company R&D.  These credits are usually offered in addition to the general R&D tax treatment of all companies in those countries. They take the form of an increased rate of a generally available tax credit (e.g., in Canada) or a completely new credit, specifically designed for small innovative firms (e.g., in Italy and Japan). They are often complemented by reduced rates of corporate income tax. 

 

The current proposal of the Finance Minister is welcome. But there is long and exciting journey that India has embarked upon. We ought to imbibe the learning and experience of other countries and fine-tune our program and use the fiscal tools to spur private sector innovation.

 

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