Tax Incentives for Research and Development and Their Use in Tax Planning

Abstract

Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW. This study provides a comprehensive analysis of various aspects of R&D tax incentives. It explains the economic justification behind the state support of research and development and summarizes its main types. In addition, it gives an overview of the existing R&D tax incentives in Europe and provides a thorough review of the empirical literature on the outcomes of fiscal incentives. Furthermore, the Devereux and Griffith model is used to determine the effective tax burden of multinational firms that reside in countries which implement R&D tax support and countries which do not. The model is developed further following Spengel and Elschner (2010) and Evers et al. (2015) to reflect a potential use of R&D tax incentives by multinational firms for tax planning. The hypothesis developed in the model is tested in an empirical estimation, where we employ the OECD data on international co-operation in patents. According to our main findings, there are at least two reasons why input-oriented R&D tax incentives, such as tax credits and tax super-deductions, constitute a more suitable instrument for fostering research and development than the output-oriented incentives, such as IP Boxes. First, there is robust evidence found in the empirical literature which shows the positive effect introducing inputoriented tax incentives has on a firm's innovative activity, whereas studies on output-oriented tax incentives are not able to support this argument. Secondly, according to our theoretical and empirical analyses, output-oriented R&D tax incentives may be used by multinationals for tax planning as opposed to their intended use of fostering research and development. Tax Incentives for Research and Development and Their Use in Tax PlanningOlenaKeywords: research and development; R&D; tax planning; corporate taxation IntroductionState support of research and development (R&D) is not only economically justified in numerous theoretical and empirical studies but is also enforced in many countries around the world. Fiscal incentives constitute one of the key instruments of state support of R&D, as they are easier to implement and are less complex to monitor than, for example, direct R&D grants or subsidies. There are various types of fiscal incentives for research and development, some of which focus on supporting the development or input phase of a research process, whereas others concentrate on the income-generating output phase. The first group of R&D tax incentives includes tax c...

Measuring R&D tax support

“…Support provided through this instrument went largely underreported in international statistics until 2007, when the OECD started the systematic collection of information on both the cost of R&D tax incentives and the design of these schemes through a dedicated survey complementing its regular data collection on R&D statistics. 6 In 2015, the reporting frequency shifted to an annual basis, thus enabling the publication of more timely data.…”

“…R&D tax relief provisions lower the cost faced by business that perform R&D or pay others to do so on their behalf. The B-Index helps identify the expected cost reduction or implied level of tax subsidy for one extra unit of R&D invested by firms (Warda, 2001[5]; OECD, 2013 [6]). What the B-Index literally identifies is a closely related concept: the pre-tax return required for a firm to financially break-even, following a decision to spend one additional monetary unit on R&D, taking into account how much tax is ultimately due.…”

“…The user cost of R&D consists of two components: an economic component that is affected by macroeconomic factors (sum of economic depreciation and discounting); and a tax component that conveys all the relevant information related to the tax system and R&D tax incentives. The tax component of the user cost is what has been commonly referred to in the literature as the B-Index, developed by Warda (2001 [5]) and extended by OECD (2013 [6]; 2018 [7]) to capture differences in the tax treatment by firm size and profitability. 35 as a measure of the cost of performing R&D, i.e.…”

“…Column (2) 6 Work is ongoing to secure differentiated reporting of grants from procurement within direct funding by countries to the OECD. Other forms of indirect support are currently not separately collected, such as repayable loans, which according to OECD Frascati Manual guidance are treated as business own funding.…”

“…Using the tax component of the user cost of R&D avoids endogeneity issues arising from its economic component. 50 Note that equation (6) has the same form as equation 2and 3when the cost of performing R&D is proxied by the B-Index, ~− .…”