Resetting and reinforcing tax incentives for entrepreneurial R&D

The 2001 legislation has been reset with a base deduction of 20% for expenses and a 50% deduction on increased expenses in comparison to the two previous tax years, making possible a six-year period for deduction of expenses.

The system has been reset in comparison to the 2001 legislation, meaning: i) an increase in the maximum amount deductible, from 500,000.00 euros to 750,000.00 euros, and ii) a longer valid period for the system, which is 5 years.

Law Nº 40/2005 of 3rd August creates the Entrepreneurial R&D Tax Incentives System (SIFIDE).

Companies’ research and development (R&D) capabilities are a decisive factor not only as a statement of competitive structures, but also for long-term productivity and economic growth. This fact is recognised in the XVII Government’s Programme and in recent international reports, namely in the conclusions of the Organisation for Economic Cooperation and Development (OECD) report - Tax Incentives for Research and Development-, 2003 and in the European Commission report on Monitoring Industrial Research-, 2004.

Preamble

In this context, Decree Law nº 292/97, of 22nd October, had already introduced a tax credit for R&D investment, SIFIDE, in 1997. From then on Portugal was no longer one of the few OECD countries with no specific fiscal instrument to support R&D, consequently minimising the unfavourable situation it was in as regards attracting qualified investment.

Given the positive results from this experimental phase of introducing tax incentives for entrepreneurial R&D, and taking into account the development of aid systems in other countries, it was decided to reinforce this aid system by means of Decree Law nº 197/2001, of 29th June, increasing the base rate level to 20% and the incremental rate to 50%, and allowing deductions to be made up to the sixth tax year thereafter. As a result of this change, 47% more new companies joined the system than the number of companies that had used it in 2000.

Given the large number of taxable persons joining this initiative and also the development of this type of aid in other countries, the tax credit system for R&D investment was extended not only for the 1998-2000 and 2001-2003 fiscal triennia (by Law nº 127-B/97, of 20th December and Law nº 3-B/2000, of 4th April, respectively), but also significantly increased the tax brackets and periods for deduction of R&D investment via Decree Law nº 197/2001, of 29th June. In fact, between 1997 and 2003, Portugal was the European Union country with the highest growth rate in entrepreneurial R&D (roughly 18% per year at constant prices), with 1061 applications registered for the incentives system from a total of 381 companies. In this way, fiscal aid has become the State’s main aid instrument for R&D in these companies, growing from 56% in 1997 to 85% in 2003 of the total for state aid, clearly replacing in importance the state financial aids that were previously the only forms of aid. The two types of state aid are heavily complementary in nature, as 58% of companies using the SIFIDE had not received any financial support for R&D under the structural funds (i.e. CAF 2 and 3). In fact, fiscal aid alone has represented more than 30% of these companies expenditure on R&D after the revision of the legislation in 2001, while previously it only covered roughly 15% of these expenses. Of further note is the fact that more than two thousand companies have been conducting R&D activities since 1995 with the SIFIDE helping increase the number of companies conducting R&D activities in Portugal, especially after its revision in 2001. Whereas the first phase was dominated by older companies traditionally investing more in entrepreneurial R&D (Chemicals, Electrical and Electronic Appliances, Telecommunications), the SIFIDE’s revision in 2001 increased the relative weighting of companies created after 1995, dominated by more modern activities and technologies, such as software, company services, technical textiles, and the emergence of biotechnology companies. The role of the SIFIDE has been even more important as a way of continuously intensifying entrepreneurial R&D. In fact, the percentage of companies investing three per cent or more of their sales in R&D increased from 42% in 1998 to 48% in 2003. Additionally, the number of companies exceeding the 100.000 contos (100,000,000 Portuguese Escudos) deduction threshold set in the 2001 legislation for the application of the incremental rate rose from 6% to 16% in two years, revealing a trend that makes updating this advisable. Furthermore, the average number of researchers per company has shot up by 50%. A study conducted for companies making use of the SIFIDE simultaneously in 1998 and 2000 revealed the important role this system played in improving the level of training of Human Resources, as these companies increased the number of graduates by 17% and the number of postgraduates by 57% in this biennium.

It was with this background that at the international level, the OECD deemed Portugal to be one of three countries with the most significant progress in entrepreneurial R&D in 2001 and that the then applicable national system was one of the most attractive and competitive when compared with other systems using deductions on the taxable amount and the distinction between the base rate and incremental rate.

The suspension of the tax incentives system under the State Budget Law in 2004 ran contrary to the expectations of economic agents who had invested in R&D and who saw themselves deprived of a fundamental aid instrument. In fact, the fiscal reserve for investment system, which was set up by Decree Law nº 23/2004, of 23rd January, cannot be seen as a replacement for the system under Decree Law nº 292/97, of 22nd October. In truth, not only is its scope more limited, but it also places investment in equipment/facilities and investment in R&D in direct confrontation, with comparatively restricted rates and other conditions for deductible expenses.

This is why it is crucial that fiscal incentives encouraging entrepreneurial R&D in cooperation with universities and other research institutions should be reset, as foreseen in the Government’s Programme, which will play an essential role in implementing the Technological Plan. The goal, to triple the R&D activities of companies operating in Portugal, can only be achieved by intensifying state aid for companies who really want to invest in scientific and technological innovation as the fulcrum of their competitiveness strategies.

Aid in the shape of tax incentives will grow in importance, not only as they are the most expeditious way for companies wishing to intensify their investment in an organised and ongoing manner, but also as they enable the effects of the financial support to be boosted. A reimbursable aid component has been introduced to the financial aid measures for R&D for consortia of companies and research institutions under the CAF 3 (POCTI and POSI), which is a considerable step forward in companies’ involvement in the projects’ results. Resetting the SIFIDE, by allowing part of the reimbursements that will be made to the financing bodies, is a just reward for the desired increased involvement.

Of the system under Decree Law nº 292/97, of 22nd October, in the wording stemming from Decree Law nº 197/2001, of 29th June, the following remain: i) the way expenses are deducted, ii) the 20% base deduction for expenses incurred and 50% deduction of increased expenses with regard to the previous two tax years, iii) the six-year period in which expenses are deductible and iv) the range of deductible expenses. Experience shows that the areas where innovation is advisable vis-à-vis this system are as follows: i) an increase in the maximum amount deductible, from 500,000.00 euros to 750,000.00 euros, and ii) setting a longer valid period for the system, which is 5 years.

Law nº 40/2005, DR nº 148, I Series A, of 3rd August 2005

Creates the SIFIDE, the Entrepreneurial R&D Tax Incentives System.

The Portuguese Assembly hereby decrees the following law pursuant to the terms of paragraph c) of article 161 of the Constitution:
 
Article 1
Subject
The subject of this law is the Entrepreneurial R&D Tax Incentives System, SIFIDE, which shall be implemented pursuant to the terms of the following articles.
 
Article 2
Concepts
For the effects of the provisions in this law, it is considered that:
“Research expenditure” means that carried out by the taxable person subject to Company Tax (IRC) with a view to acquiring new scientific or technical knowledge; “Development expenditure” means that carried out by the taxable person subject to Company Tax (IRC) through harnessing the results of research work or from other scientific or technical knowledge with a view to discovering or substantially improving raw materials, products, services or manufacturing processes.
 
Article 3
Eligible expenses
1-The following categories of expenses are deemed deductible, provided they refer to research and development activities, as outlined in the previous article:
a) Acquisitions of fixed assets, with the exception of buildings and land, provided they are created or acquired new and are directly linked to R&D activities;
b) Expenses on staff directly involved in R&D duties;
c) Expenses on executives and management managing R&D institutions;
d) Operating expenses up to a maximum 55% of expenses on staff directly involved in R&D duties through pay, wages or salaries relating to that tax year;
e) Expenses from tendering R&D activities with public bodies or beneficiaries of public utility status or entities whose expertise in the research and development field is recognised by joint order of the Minister of the Economy and the Minister for Innovation and the Minister for Science, Technology and Higher Education;
f) Stakes in the share capital of R&D institutions and contributions to public or private investment funds to finance companies dedicated in particular to R&D, including funding for using their results, whose expertise in the research and development field is recognised by joint order of the Minister of the Economy and the Minister for Innovation and the Minister for Science, Technology and Higher Education;
g) Costs related to registering and maintaining patents;
h) Expenses related to the acquisition of patents predominantly for R&D activities;
i) Expenditure on R&D audits.
2-The bodies mentioned in paragraph e) may not deduct any type of expenses incurred through projects carried out by third parties.
3-The costs mentioned in paragraph g) shall apply to micro, small and medium-sized companies only.
 
Article 4
Scope of deductions
1-taxable person subject to Company Tax (IRC)s resident in Portugal who perform, as their main activity or not, an agricultural, industrial, commercial or services activity and non-residents with a stable establishment in the country may deduct from the amount calculated under article 83 of the Company Tax (IRC) Code up to its application the equivalent value for expenditure on research and development on the amount that has not been co-funded by the State through non-refundable funding carried out during the taxable period starting on 1st January 2006 by means of a double percentage:
a) Base rate of 20% on expenses over this period;
b) Incremental rate of 50% on increased expenditure over this period related to the simple mathematical average of the previous two tax years up to a limit of -750,000, which may be revised by decree-law.
2-The deduction is made to the liquidated amount for the tax period mentioned in the previous number, pursuant to article 83 of the IRC Code.
3. Expenses that cannot be deducted during the financial year they were incurred through deficiency of the taxable amount may be deducted up to the 6th financial year thereafter.
4-For the effects of the provisions of the previous numbers, when there is a change in the tax period in the year the benefits start, the annual period starting that year shall be taken.
 
Article 5
Conditions
Only taxable persons under Company Tax (IRC) who cumulatively meet the following conditions may benefit from the deduction mentioned in article 4:
a) Their taxable profit is not determined by indirect means;
b) They do not owe the State and the Social Security System any tax or contributions, or have their payments duly in order.
 
Article 6
Accessory obligations
1-The deduction mentioned in article 4 has to be justified by a statement of proof, which the interested bodies can request, or proof that they have requested such a document be issued, that the activities carried out or to be carried out are actually research and development actions, of the respective amounts involved, of the calculation of added expenses with regard to the average of the previous two financial years and other factors deemed pertinent, issued by a body named by order of the Minister for Science, Technology and Higher Education, to be included in the taxable person’s tax documentation referred to in article 121 of the Company Tax (IRC) Code.
2-The taxable person’s tax documentation must also include a document showing calculation of the tax break, as well as documental proof that the condition mentioned in paragraph b) o article 5 is met, with reference to the month prior to the month the tax return is filed.
3-Entities interested in using the tax incentives system foreseen in this law must make the information requested by the entity mentioned in nº 1 in a timely fashion and agree to be subject to technology audits deemed necessary.
 
Article 7
Accounting obligations
The accounts department/accountant of the taxable person(s) subject to Company Tax (IRC) benefiting from the system outlined in this law shall mention the tax no longer being paid due to the effects of the deduction referred to in article 4, mentioning the corresponding value in the annex to the balance sheet and income statement for the financial year in which the deduction is made.
 
Article 8
Exclusivity of benefit
The deduction mentioned in article 4 is not accruable, as regards the same investment, with tax benefits of the same nature as foreseen in other laws.
 
Article 9
Validity
The arrangement in this law shall be valid for a period of five years.
 
Approved on 16th June 2005.
President of the Portuguese Assembly, Jaime Gama.
Promulgated on 21st July 2005.
Published.
The President of the Republic, JORGE SAMPAIO.
Countersigned on 22nd July 2005.
The Prime Minister, José Sócrates Carvalho Pinto de Sousa.